New York Markets After Hours

Controlling your heirs from beyond

Irrevocable trusts can let you strict conditions

By

LauraSaunders

Can you force a grandchild to take a drug test in order to receive an inheritance? Insist your heirs use trust funds only for tuition at your alma mater? Make sure your wife’s future husbands can’t run through money you worked hard to earn?

In many cases, the answer is yes—you can, in effect, control your heirs from the grave.

The issue of what you can give away and how is especially relevant now because unusually favorable estate- and gift-tax rules are set to expire. The “exemption” for both—which is the amount of assets a taxpayer can transfer to others, tax-free, either at death or through gifts while alive—is now $5.12 million per individual, and twice that for a couple. The top tax rate on amounts above that is 35%.

TAXES

Big tax bills can devastate your retirement
savings. MarketWatch's Robert Powell and Andrea Coombes talk about strategies to employ before and during retirement to lower your taxes.

But not for long. In January the exemption is slated to drop to $1 million per person, and the top tax rate will jump to 55%. Although many experts don’t think those changes will stick because they are so unfavorable, a new regime might well be less generous. President Barack Obama favors a $3.5 million exemption and a 45% top rate.

With the law in flux, experts are recommending that wealthier taxpayers who can afford to part with assets make gifts of them this year. The rationale: if the law becomes less favorable, this year’s gifts either will be grandfathered in or, at worst, won’t be “clawed back” until death.

Clients are listening. “For this year I’ll be filing three times as many gift-tax returns as I have in the past,” says Lauren Wolven, a tax expert at law firm Horwood, Marcus & Berk in Chicago.

“It’s as if a cork popped out of a bottle,” adds Joe McDonald, an attorney at McDonald & Kanyuk in Concord, N.H.

As with many good tax deals, there is a hitch: Taxpayers taking advantage of the exemption by making gifts have to give up control of assets today. Typically that means putting them into “irrevocable trusts” that require up-front decisions about who will get what, when and for how many years thereafter.

So what does the law permit? Surprises, at times. Leona Helmsley, the widow of billionaire real-estate magnate Harry Helmsley, left a trust to care for her beloved dog, Trouble, after her death. Leona Helmsley also required her grandchildren to visit their father’s grave once a year in order to receive payouts.

For people scrambling to set up trusts before year-end, here are some important considerations. And for those who don’t have millions to give, the good news is that most of the same rules governing trusts apply to ordinary wills as well.

Give as you wish—sort of

In general the law is biased toward allowing people to leave assets as they wish—even if the wish seems silly. Nearly 100 years ago, a Connecticut court upheld a requirement that heirs had to spell the family name in a certain way to receive a payout. (It was Tyrrel.)

But there are limits. One is for provisions “contrary to public policy.” This category has always included requirements that promote divorce or criminal behavior; now it extends to racial discrimination. For example, courts have struck down provisions leaving money for scholarships for white girls.

Discouraging marriage also is frowned on. A court would almost certainly invalidate a provision requiring a daughter to remain unmarried in order to receive her trust payout. But people are free to put assets in trusts that bypass the future partners of a spouse.

Also problematic are ambiguous, illegal or impossible-to-satisfy provisions—such as one that required a treasured snowball collection to be preserved in a freezer. (What if the electricity went out?)

What is allowed varies according to state law. A Missouri court once struck down as too vague a provision requiring brothers to be capable of “prudent exercise, control and ownership” of a piece of real estate so that “no further danger shall exist.”

But vagueness didn’t prevent Northern Trust Chief Fiduciary Officer Hugh Magill, based in Chicago, from recently requiring a man in his mid-50s to prove he was “of sound mind, good moral character and temperate financial habits”—as a trust for the man required. Among other things, the heir submitted three years of tax returns, a financial statement and a letter of support from his minister; he got the money.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
All quotes are in local exchange time. Real time last sale data provided by NASDAQ. More
information on NASDAQ traded symbols and their current financial status. Intraday
data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. S&P/Dow Jones Indices (SM)
from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.